Compliance and Donald Trumps spoiled child

[Disclaimer: The below views and information is not
based on experience from one financial institution, but based on dialogues with
numerous financial institutions from most parts of the world – during a long
period of time.]

I once thought that the issue of regulatory
compliance within Trade Finance would find its natural balance. Now; I hope it
will – but I am by no means sure about it.

I thought that by starting to speak the
“language” of compliance, by showing as honest and transparent as possible the
risks and features of Trade Finance, by having an open mind as to the
requirements etc. etc. the compliance officers and auditors and regulators
would stop their constantly increasing of compliance requirements on the Trade
Finance departments.

That was not correct – or rather: At least
for the compliance officers and auditors that was not correct. In fact an
observation is that it is easier to have a constructive dialogue with a local
regulator than with an internal auditor or compliance officer.

I have been spending some time wondering
about why that is so. I am sure there are many explanations, but I have a
“business case thesis” that I want to share with you:

In most things you do – and especially if
you are a company – you take a business case approach: If you buy this IT
software for EUR xxx.xxx,xx then what will be the “profit”? The “profit” need
not be that your income increases + EUR xxx.xxx,xx, it could be also that you
get to keep customers that would otherwise leave you, or that your rate of
errors (possible losses) decreases. The point is that any investment normally comes
with a business case: There must be sufficient “value” from the result to
justify the investment.

In many ways compliance is an “investment”.

At least the Trade Finance department knows that. Most Trade Finance departments
strive really hard to balance their “compliance activities”. On one hand they
must be “in compliance” (whatever that means) and on the other they must be
able to actually serve the customers and do the business. I.e. the Trade
Finance department will aim to do what they need to do – but nothing more than
that, and at the lowest possible cost.

For the regulators there is also a balance. They report to the government
who both 1) want to ensure that the banks take the appropriate measures to
avoid facilitation of money laundering and beaching sanctions, and 2) want to
ensure that the banks are still able to do the business. After all most
countries strive for growth – and a lot of growth comes from trade, so there is
an interest in finding the right balance. A too strict approach to the banks may
result in “de-risking” i.e. that certain “high risk transactions” (geographies,
industries etc.) will no longer be handled by the banks.

The EU has even made the following
statement:

“…the balance of costs and benefits to
institutions and persons covered by this Directive on a long-term basis in any
implementing measures; the need to respect the necessary flexibility in the
application of the implementing measures in accordance with a risk-sensitive
approach …” *)

For the compliance officers and auditors the dynamics are different. Their
main role is to ensure that the bank is “in compliance”. As is common knowledge;
to be “in compliance” is far from black and white. I.e. the requirements that
apply to a particular bank are not carved in stone. It is often for the
compliance officers (together with group legal and the auditors) to interpret
the applicable regulations, and draft internal policies based on those.

Given that 1) the applicable regulations is
phrased rather “loose” and 2) that compliance officers often do not know the
Trade Finance products in details, any compliance officer is likely to take the
stricter approach. Add to that, that many fingers will point to the compliance
officers in case of any kind of criticism (or fines) from local regulators. In
other words: the likelihood that the compliance requirement is applied very
strict ( stricter than is the intention from the regulators) is very high. On
top of that the management is reluctant – perhaps even unable to challenge the
requirements set by the compliance officers. The stakes ( potential fines) are
too high. Compliance is not something to mess with!

This means that for the compliance officers
the “business case” need not balance at all. In fact it is a “reverse business
case”. The stricter the requirements, the more “safe” is the compliance
officer. And in any case the compliance officers need not consider the cost of
their requirements in respect of the “value” of the “investment”. They are
(almost) free to set the requirements they deem fit. Therefore there are no limits!
No need to prioritize the required controls. In that process the logic is
similar to that of a child that does not meet any boundaries whatsoever. They
constantly push for more. Every time they get a new toy, they demand the next
and the next and the next. Potentially this makes any compliance officer Donald
Trumps spoiled child at Christmas who can just point to anything and get it –
regardless of the cost.

The consequences of that is that many banks
have implemented controls that are far beyond what any regulator is likely to
set, with the result that:

* The prices of Trade Finance increases

* The handling of each transaction takes
longer

* The banks de-risk their business

* The banks turn down good and solid
transactions

In other words: The balance that (for
example) the EU strives for get lost somewhere between the requirements from
the regulators and the implementation in the Trade Finance departments.

From the above it may sound as if I am
“against” compliance. That is totally wrong. A good and solid compliance set-up
has many advantages both for the bank and for the customers of the bank. And by
good and solid I mean that there are controls in place that address the actual risk at the particular bank. Also
in Trade Finance there must be a risk-based approach. The controls in place
should be based on a “risk assessment” – so that the “risk picture” is clear –
and the controls are designed to address those risks.

lcviews have published a “white paper on
Trade Finance Compliance” with the purpose of suggesting how to work with
compliance in the banks Trade Finance departments. That document is available
on the lcviews website free of charge for your reference. It caters strongly
for the Trade Finance departments to get in the driver sets – especially when
it comes to compliance.

I once thought that the issue of regulatory
compliance within Trade Finance would find its natural balance. Now I hope it
will – but I am by no means sure about it. But I really hope it a lot – because
if no one sets boundaries for Donald Trumps spoiled child it will become
increasingly hard to do Trade Finance.

All I ask for is that we take care of each
other – and the LC!

Kind regards

Kim

*) From: DIRECTIVE 2005/60/EC OF THE
EUROPEAN PARLIAMENT AND OF THE COUNCIL of 26 October 2005 on the prevention of
the use of the financial system for the purpose of money laundering and
terrorist financing (The EU Directive).

The full text goes:

“In exercising its implementing powers
in accordance with this Directive, the Commission should respect the following
principles: the need for high levels of transparency and consultation with
institutions and persons covered by this Directive and with the European
Parliament and the Council; the need to ensure that competent authorities will
be able to ensure compliance with the rules consistently; the balance of costs
and benefits to institutions and persons covered by this Directive on a
long-term basis in any implementing measures; the need to respect the necessary
flexibility in the application of the implementing measures in accordance with
a risk-sensitive approach; the need to ensure coherence with other Community
legislation in this area; the need to protect the Community, its Member States
and their citizens from the consequences of money laundering and terrorist
financing.”